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Hedge fund urges Dow to spin off petrochemicals

01.22.2014  | 

Third Point’s stake in Dow is its largest current investment, the hedge fund said in a letter to investors. Dow should hire external advisers to review strategy and potential benefits of a spinoff, Third Point said.

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By JACK KASKEY
Bloomberg

Third Point, the hedge fund led by billionaire Daniel Loeb, took a stake in Dow Chemical and called for a spinoff of its petrochemicals business to improve profitability.

Third Point’s stake in Dow is its largest current investment, the hedge fund said in a letter to investors. Dow should hire external advisers to review its strategy and the potential benefits of a spinoff, Third Point said.

While Third Point has been talking with Dow since late last year, those discussions haven’t included the chief executive officer or board members of the company, said a person with knowledge of the matter. The fund’s stake has a value of about $1.3 billion, the person said, asking not to be identified as the information is private.

Dow’s share performance has lagged behind competitors that are more focused on petrochemicals, such as LyondellBasell and Westlake Chemical, as new drilling methods in US shale formations unlock an abundance of natural gas. Shale gas has slashed costs for chemical makers such as Dow that use gas both as a raw material and to power factories.

“We believe the benefits from a spinoff, including financial uplift from operational improvements at Dow Petchem Co. and the potential valuation uplift from increased business focus and disclosure, far outweigh the supposed integration benefits,” Third Point said in the letter.

Dow jumped 6.6% on Tuesday to $45.93 at the close in New York, the biggest gain in more than two years.

Specialty Businesses

In nine years leading the company, Dow CEO Andrew Liveris, 59, has tried to boost profit by focusing on specialty businesses such as pesticides, genetically modified seeds, paint ingredients and electronics. He tried to sell a 50% percent stake in the plastics unit to Kuwait, a deal that failed in 2009 amid the financial crisis.

The tables have turned on Dow as US shale gas has increased earnings from petrochemicals, Third Point said in the letter. Petrochemicals in most of the world are made from naphtha, an oil derivative whose price reflects a tripling of oil prices since the end of 2008, widening the advantage of US gas-based production, according to Bloomberg.

“Dow’s current petrochemical strategy seems misaligned with the changed landscape,” Third Point said in the letter.

Cost cuts and improved operations in the petrochemicals business could add “several billion dollars” to earnings before interest, taxes, depreciation and amortization, Third Point said. That would boost petrochemical Ebitda to more than $9 billion, more than the whole company currently earns, Third Point said.

‘Constructive Input’

Dow management and directors constantly look for ways to increase shareholder value and competitiveness, Rebecca Bentley, a Dow spokeswoman, said.

“We welcome all constructive input with a common goal of enhancing long-term value,” Bentley said. “We intend to continue an open dialog to further enhance value for all of our shareholders.”

A petrochemical-focused Dow spinoff would generally include the performance-plastics, performance-materials and feedstocks- and-energy units, Third Point said. Those businesses had $37.9 billion of revenue in the 12 months through September, or 67% of Dow’s $56.6 billion of sales, according to data compiled by Bloomberg.

Breaking up Dow would help unlock shareholder value, Hassan Ahmed, a New York-based analyst at Alembic Global Advisors who recommends buying the shares, said in a note.

Doubled Value

The shale gas advantage probably has doubled the value of the plastics business since 2008 to $38 billion, while the agriculture unit is worth $12 billion and Dow’s joint ventures are worth $10 billion, not much less than the current value of the entire company, he said.

“The market does not seem to be assigning much value at all to the expected growth at the company, or the $35 billion in sales and $4 billion in Ebitda generated by the company’s more ‘specialty’ businesses,” Ahmed said.

Liveris said in October that he plans to divest $3 billion to $4 billion of assets within two years as the company seeks to move away from less profitable commodity chemicals and focus on value-added products. The largest unit targeted for sale is chlorine, which isn’t a petrochemical.

Dow joins competitors such as DuPont in facing pressure from activist investors. Nelson Peltz’s Trian Fund Management, a New York-based hedge fund, last year took stakes in DuPont, which now plans to spin off the unit that makes titanium dioxide, a white pigment used in paint and plastics. Ashland announced plans to sell its water-chemicals unit after Jana Partners bought a stake.

Lagging Index

Dow climbed 27% in the 12 months through Jan. 17, compared with a 23% gain in the Standard & Poor’s 500 Chemicals Index. Before Tuesday, Dow fell 4.2% since the last trading before Liveris became CEO on Nov. 1, 2004, while the S&P 500 Chemicals Index more than doubled.

Dow was valued last week at about 22 times its trailing 12-month earnings per share, according to data compiled by Bloomberg. Chemical companies that have market values exceeding $20 billion fetch a median price-earnings ratio of 20, the data show.

Dow earned 6.7 cents of operating profit for every dollar of sales in the 12 months that ended in September, among the lowest margins of its peers, data compiled by Bloomberg show. The company is scheduled to report fourth-quarter earnings Jan. 29.

Share Buyback

Third Point also urged Dow to consider “a meaningful share buyback” to offset shares that will one day be issued to Warren Buffett’s Berkshire Hathaway and the Kuwait Investment Authority when they convert $4 billion of Dow preferred securities.

Loeb also disclosed the fund had amassed about 9.5% of Ally Financial through a series of private transactions. The fund reported an increased stake in Intrexon, the synthetic biology services provider that Third Point had invested in privately since 2011 and which had an initial public offering in August.

In 2013 Loeb took activist stakes in new targets including Sony, where he called for a partial sale of the Japanese company’s entertainment unit, CF Industries, where he agitated for a larger dividend, and Sotheby’s, where he pushed for new leadership and more efficient operations.



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